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The Changing Structure of Wages and its Impact on Prices
-Will the Recovery of Wages Exacerbate Inflationary Pressure?-

May 18, 2005

Overview

This article looks at the questions of when Japan is likely to achieve its escape from deflation and what will become of its price structure after that escape, with a focus on the impact of wage trends on prices.

Wages are recovering on a macroeconomic basis, but the recovery is largely in the manufacturing sector, and in the non-manufacturing sector they are still following a downward trend.

Change in Japan's wage structure in recent years has been characterized by increased flexibility and widening wage gaps. The change in the basis for deciding wages, from "years of service and ability" to "duties and business performance" and the higher proportion of non-regular employment has accelerated the process of wage adjustment. Moreover, the recent changes in the structure of wages and employment have tended to cause wage gaps to widen.

In macro terms, there are two routes by which wages affect prices:
(i) Through a tightening of the balance of supply and demand due to increased demand
With the recovery of wages and employment still proceeding at a slow pace, the pace of consumption has not accelerated and inflationary pressure from this quarter is limited.
(ii) Through the transfer of cost increases to prices
In the manufacturing sector, where wages are rising, increased productivity has absorbed pressure for the transfer of costs to prices; in the non-manufacturing sector, where increases in wage costs are more readily passed on to prices, efforts to curb wages continue.

Although consumer prices remain stable at a macroeconomic level, the polarization of incomes due to the widening of wage gaps will exert pressure for polarization on the price structure. Consumers in higher income bands will come to purchase more up-market and high-value-added goods, while consumption by those in lower income bands will increasingly center on commodity-type goods.

In such an "age of price polarization", companies should not look for a second coming of inflation in the hope that it will become easier to pass cost increases on to prices but should adopt a pricing strategy based on the individual characteristics of each product or service.

What are the implications for monetary policy? By the end of 2006, it seems possible that the economy will reach a stage where it will be practicable, in price terms, to discontinue the policy of quantitative monetary easing. At this time, pressure for inflation will not be particularly strong and the monetary authorities should have sufficient room for maneuver to allow adequate preparations for the discontinuation. If Japan is to achieve sustained economic growth through wage growth coupled with price stability, two policy issues on the real economic front will be increasing productivity in the non-manufacturing sector and resolving the mismatch between labor supply and demand.

For more information on the content of this report, please contact: Hisashi Yamada the Japan Research Institute, Limited.

Tel: 03-3288-4245
E-mail:yamada@rsc.jri.co.jp

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